The Experts

Can improving business conditions be sustained?

As John Maynard Keyes once said, “when the facts change, I change my mind”.

Despite my relatively downbeat outlook for the economy over recent times, the surprisingly strong lift in the National Australia Bank survey measure of business conditions in March is enough to make even sceptics like me sit up and take notice.

According to the NAB March survey, business conditions leapt from +8 points in February to +12, to be now comfortably above the long-run average of around +5 points. Gains were fairly broad based across components and industries: sales, profits and employment indicators all rose, while only the mining and retailing sectors reported a drop in conditions.

Source: NAB

Indeed, according to the NAB, business conditions are now at above average levels in all sectors apart from (the headline dominating) retailing and mining sectors. Capacity utilisation also rose, which has tended in the past to be a good leading indicator of declines in the unemployment rate. NAB Economics reckon the unemployment rate will drop to 5.6% by the end of this year, and 5.5% by end-2017.

If right, we can forget about any further interest rate cuts from the Reserve Bank and the $A may well remain uncomfortably high this year even if commodity prices decline.

So far so good, but I still can’t help but wonder what accounts for all this good cheer?

After all, we know the mining investment slump is still underway, and there are almost daily reports of another major manufacturing or mining plant shutting its doors. Retail sales remain subdued and consumer confidence is at below-average levels. Home building approvals are trending down.

Looking into the sector details, several features are apparent.

For starters, business conditions in the broad church of business and consumer services continue to chug along at the same relatively high level they’ve sustained over the past year or so.

Perhaps surprisingly, what’s accounted for the trend improvement in business conditions over the past year has been gains in the previously weak construction, manufacturing and transportation sectors in particular. Against this, conditions in the mining and the retail/wholesale sectors have been more subdued.

Business Conditions by Sector (net balance)-3 month moving average

Source:NAB

Let’s dig a little further. The strength in services clearly reflects the ongoing structural shift toward areas such as education, health and leisure services. More labour market flexibility appears to have greatly helped, as reflected in flexible working arrangements and subdued growth in labour costs.

The pipeline of home building projects – largely due to low interest rates - is also no doubt being reflected in improved demand for property and legal business services, not to mention manufacturing and construction. And the boom in bulk commodity export shipments (albeit at subdued prices) may account for improved transportation activity.

The weaker $A (at least up until lately) has also led to improved tourism and, perhaps to a more limited degree, better manufacturing competitiveness. More broadly, the internet/technology revolution – and possibly even our spate of free-trade agreements – could also be spawning new growth opportunities.

So all up, there do appear plausible reasons why the economy may well have improved and, if so, this is testament once again to its flexibility in the face of shocks.

Indeed, in view of the regularly reported tales of manufacturing woe due to major plant closures, the public may be surprised to know that – according to the NAB survey at least – manufacturing business conditions have been steadily improving, and are now at above-average levels!

Low interest rate and a low(ish) Australian dollar are doing their job, as are the hard fought gains in labour market flexibility. Australia’s longstanding willingness to embrace free trade and new consumer technologies are other positives.

As Peter regularly reminds us, the economy does have a lot going for it and sometimes the media tends to overly dwell on the negative. That said, I do worry that the apparent economic gloss may come off as the gathering downturn in home building takes effect and if the $A remains stubbornly high. As even the NAB admit, moreover, its survey has tended to over predict economic growth in recent years, for reasons as yet unclear.

But I do concede the facts may be changing. If so, I may need to change my mind.